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What Is a Shareholder Agreement?

Sammi Caramela
Sammi Caramela

With a shareholders' agreement, your corporation can avoid legal issues and challenges.

When you run a business with multiple shareholders, like a C corporation or S corporation, there are bound to be differences among company owners. In some unfortunate circumstances, these differences may cause an irreparable rift in the company. To prevent this from happening, a shareholders' agreement should be created to ensure the business remains operational when disagreements occur.

"Every shareholder has their own vision for what the company should be," said Nate Masterson, marketing manager for Maple Holistics. "While more often than not there's a lot of crossovers, on occasion, there will be points of disagreements that are untenable. Having a shareholders' agreement can prevent a shareholder from enforcing their will in a destructive manner, regardless of how the other shareholders feel."

While you are not obliged to create a shareholders' agreement, doing so will prevent potential legal issues down the line. Here's how to create your agreement, and what to include.

What is a shareholder agreement?

According to Investopedia, a shareholders' agreement is "an arrangement among a company's shareholders that describes how the company should be operated and outlines shareholders' rights and obligations."

The agreement, not to be confused with articles of incorporation, is an informal document that is created and settled by all shareholders. It helps ease the process of many business resolutions, like removing a shareholder or selling or purchasing shares. Without an agreement, shareholders won't have a compromised set of guidelines or rights, which can lead to conflict and one-sided decisions.

Reaching a consensus

It can be difficult for everyone to agree, especially if you have numerous shareholders. But it's imperative to work out all the details and kinks before signing your business agreement. If your terms aren't settling well with the other shareholders, reconsider your position, said Masterson.

"You should always be prepared to leave the negotiation table if certain conditions aren't met," he added. "It's very important that everyone is on the same page before an agreement is signed."

To ensure you're on the right track with the agreement, consider hiring legal help. That way, you won't be misrepresented or underrepresented.

"When signing a contract that requires conduct from you, it’s imperative that you seek legal counsel if only to make sure you can or want to comply," said Masterson.

What to include in a shareholder's agreement?

There are many points to cover in your shareholder agreement. This varies depending on the corporation and shareholders involved. Masterson outlined a few provisions that are necessary:

  • The right to remove directors
  • Terms that protect minority shareholders
  • Restrictions on how and when someone can dispose of their shares
  • Limitations on the actions a director can take
  • A business plan that ensures that all shareholders are sharing the same vision
  • Steps on how to resolve shareholder disputes

He also noted two significant clauses: The right of first refusal, which ensures new stocks will be offered to the minority shareholders first; and piggyback rights, which give minority shareholders the right to be included when majority shareholders sell stock.

Additionally, it's important to protect intellectual property when drafting your agreement. This acts as copyright for any creative manuscripts or ideas belong to the individual who invented them, rather than the corporation as a whole.

There is no right or wrong when deciding what to include in your business agreement. As long as everyone is on the same page and fairly represented, and critical points are covered, there shouldn't be any issues.

Shareholders agreement FAQs

Who needs to sign the shareholder agreement?

Every shareholder must agree to the terms of the agreement and sign it alongside a company representative. If the shareholders don't know or trust one another, it may be best to have each signature be witnessed or notarized to prevent future conflicts.

Is a shareholder agreement necessary?

Although a shareholder agreement is not legally required when two or more people own a corporation, it is in the best interest of every shareholder to decide what rights they have, what rights they don’t have, how the business will be operated and how to resolve any disputes or disagreements.

When should a shareholder agreement be created?

Ideally, a shareholder agreement is created once there is more than one person who is investing money into the business. Prior to that, a shareholder agreement is not necessary.

When should your shareholder agreement end?

Generally speaking, there are two ways to end a shareholder agreement. You may choose to set a specific date in which the agreement ends, or you can specify an option to end it when all shareholders agree to end it. However, if you are planning to add new shareholders, if there are already a large number of shareholders, or if you believe there will be conflict among them, it may be best to select a specific date to end the agreement.

The option to end the agreement when all shareholders decide that is what is best for the corporation should only be available when the corporation is closely held, meaning there are few shareholders, and they have a positive working relationship. Otherwise, just one dissenting vote to end the agreement will prevent it from closing.

However, a shareholder agreement may be automatically terminated if a shareholder breaches the contract, though there may be provisions in the agreement to map out what steps should be taken if that does occur.

Do public companies have shareholder agreements?

Any company, regardless of if they are private or public, that has two or more shareholders is best served having a shareholder agreement to define how the company should be operated and, more importantly, outline each shareholder's rights and responsibilities.

Are shareholder agreements binding?

Yes, a shareholder agreement is a legally contractual agreement. The purpose of the agreement is to protect investments and declare what shareholders may or may not do. However, it is not legally required to create a shareholder agreement, though it is in the best interests of every party to put one in place to avoid potential conflicts.

Additional reporting by Sean Peek.

Image Credit: BRAIN2HANDS/Shutterstock
Sammi Caramela
Sammi Caramela,
business.com Writer
See Sammi Caramela's Profile
Sammi Caramela has always loved words. When she isn't writing for business.com and Business News Daily, she's writing (and furiously editing) her first novel, reading a YA book with a third cup of coffee, or attending local pop-punk concerts. She is also the content manager for Lightning Media Partners. Check out her short stories in "Night Light: Haunted Tales of Terror," which is sold on Amazon.